Tech

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

In the car industry's future, the coder will be king. That's the belief that propelled Mobileye's shares to giddy heights after its U.S. listing back in 2014.

Tesla Two-Step
Bloomberg

But the past few months have shaken anyone who thinks the Israeli tech supplier has a permanent claim to the throne. After touching a high of more than $64 in August, the shares fell this week to below $25, the IPO price. They've fallen victim to a burst of market sanity that's also started to rein in Tesla, another "disrupter" of the staid old autos industry. Mobileye is a Tesla supplier.

That's not to say the Israeli company fully merits such a prolonged kicking from short-sellers, whose interest still accounts for one-quarter of the float. (Citron Research called it the 2016 "short of the year.")

The modern car comes packed full of computer code and electronics that increasingly lets it drive itself, the kind of stuff supplied by the Israeli company. Automakers could be relegated one day to mere assemblers, with most of the profit going to providers of this high-tech kit.

The question for Mobileye is how much of that market it can grab, with parts suppliers, chipmakers and Google all jostling for some of the self-driving action.

Autonomy Pays
Advanced driver assistance systems are among the fastest-growing car parts sectors
Source: just-auto.com (via Bloomberg Intelligence)
Figures are estimates for 2015

The Israeli supplier has certainly made inroads. Its camera-based algorithms make a car brake automatically if another vehicle or pedestrian crosses its path, and it partners with every big automaker bar Daimler and Toyota. 

Even after the recent decline, its shares still trade at a hefty 54 times 2015 earnings and 34 times next year's, three times the average of selected auto-supplier peers. It may well have further to fall, but the volatility risks distracting from some decent fundamentals.

Because of stricter requirements for automatic braking, it should keep increasing sales and earnings at double-digit rates for a few years at least. As such, it merits a higher multiple than rivals such as Continental or Autoliv. Thanks to low fixed costs (it doesn't build chips or cameras), free cash flow is expected to be almost 100 million euros in 2015.

Self-Driving Margins
Mobileye's operating margins far exceed those of auto supplier peers
Bloomberg data (latest quarter)

Its technology also creates a barrier to entry, despite Citron's argument otherwise. The carmakers can't afford these systems to malfunction given the potential for litigation and recalls. Every carmaker that buys Mobileye chips adds to the data pool used to optimize its algorithms, making them safer. Competitors may take years to catch up.

That said, while Mobileye has a head-start, its market share and margins will normalize eventually. Chipmakers such as Nvidia are pushing into the field. Auto suppliers Bosch, Continental, Denso and Autoliv are rushing to improve algorithms -- and they have deep pockets. Conti bought Finnish algorithm company Elektrobit last year for 600 million euros and Bosch spent almost 5 billion euros on R&D in 2014, or 10 percent of sales. Google's also developing self-driving software.

Carmakers have little choice for now other than to use Mobileye technology because it's the most cost-effective, but they don't like being dependent on a single supplier and are renowned for squeezing supplier margins. Mobileye should expect rivals to get stronger and shareholders should expect a smaller proportion of profit in the long-term. It wouldn't be immune to any downturn in car demand.

Still, presented with the choice between owning a capital-intensive manufacturer or an asset-light software maker, investors are wise to favor the latter. Mobileye's under pressure but the future belongs to the geeks, not the metal-bashers.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net